In my last post on emergency funds, I looked at Dave Ramsey’s (and many others’) suggestion of an emergency fund size of three to six months of expenses and calculated what that would be for our current budget ($7,500 to $15,000). But at the end of the post I questioned whether a three to six month emergency fund is really appropriate for us. I am an overthinker, so I have trouble just accepting that we need three to six months of expenses put aside to do nothing but contend with potential emergencies.

Do you know how many times we’ve accessed emergency money in the last six years? Zero. We’ve used our savings plenty of times, but (and I know I’m inviting Murphy here) we have yet to have an emergency. We’ve had to repair our cars several times, but that sort of expense isn’t unanticipated. Even when we have had deaths in the family we were able to cover our travel out of our Travel targeted savings account or our plane tickets were given to us by another family member. We have never had to pay for non-routine medical expenses, and if we did we have a bit of money set aside for that purpose.

What Is An Emergency Fund For?

I reviewed many articles and blog posts on determining emergency fund size, which I will link to as part of this post. There are generally two categories of expenses people want an emergency fund to provide for: job loss and broken things. In my observation, calculations of EF size use one or the other approach but usually not both.

Wealth Informatics calculates a personalized emergency fund size accounting for both job loss and broken things. This post is modeled after her approach so I highly recommend you check it out.

Job Loss

By far the most popular reason for having an EF is to cover basic expenses in the case of job loss. That’s why the standard advice for how large an EF should be went from “three to six months” pre-recession to “six to nine months” during the recession. People believe that in the “new economy,” jobs are not very secure and finding another one will take significant time. Expenses instead of income are used as a nod to the hope that you’re living under your means before the job loss, but there is not much discussion of how a married couple or people with multiple income streams should adapt the advice – there is inherently more income stability when it is coming from diverse sources.

Broken Things

The situations that most people probably think of when they hear the word “emergency” are unexpected medical problem, car troubles, or housing repairs. Basically anything that is a large asset (including yourself) may need money spent on it to become functional, and there are a few things that you really need to be functional. Having to travel unexpectedly for a family emergency may be another “broken thing” to consider for your EF.

What Should My/Your Emergency Fund Cover?

While “three to six months of expenses” isn’t a bad place to start, the generic advice may leave you with an underfunded EF (and up a creek if you ever actually need it) or the opportunity cost associated with having too much money sitting in cash. (This opportunity cost is why many will advocate keeping a smaller EF while paying of non-mortgage debt.) In the remainder of the post I’ll show you how I’m calculating my personalized emergency fund; you can do a similar exercise for your situation.

Job Loss vs. Broken Things

I think it’s reasonable to consider either the job loss approach or the broken things approach to calculating an emergency fund size and go with the larger.

Kyle and I are not at all fearful of job loss or unemployment. I realize that is uncommon – it’s directly related to our positions as grad students. You have to consider how diversified your income sources are, the security of your current position, the unemployment rate of your particular field, and the job opportunities in your local area. If you’re self-employed or have a variable income you’ll want even more savings in place, whether it’s for smoothing out your income or to keep you afloat when you aren’t bringing any money in.

Given that we weathered the Great Recession in our respective advisors’ labs, it’s unlikely that we will find ourselves without a job unless we have graduated. Even in that case, it’s fairly routine for a new PhD to stay in her same lab until she finds a postdoc (this will be what Kyle does next semester). I actually think it’s more likely that one of us would become ill and have to take a leave of absence than to be kicked out of our lab. And for both of us to lose our positions at the same time, I think our university would have to become inoperable or the government to stay shut down forever.

Even if one of us does lose our position or funding, I have worked out an emergency budget in the case of only one of us pulling an income and with it we are only about $100/month in the red. It’s likely that we could make up that difference in desperate-times side hustle income (if we are both healthy) each month so we wouldn’t even have to dip into savings.

Basically, our secure positions plus that there are two of us making the same income plus our relatively low monthly nut means that our present situation makes the need for a job-loss-related EF quite low.

On the other side of the equation, we do have things like our bodies and car that we would like to keep in working order should they decide to malfunction, so I think our EF should be based on preparing for the possibility of broken things.

Things You Own that Could Break

Try to think of all the things you would need to replace or repair swiftly if they broke. Is that a long list or a short list? How many of those items do you have insurance or sinking funds for?

Homeowners are definitely going to have the longest list. If some kind of disaster struck your house, I would hope you have the proper insurance in place. As far as repairs go, do you have a savings account for repairs or would that be considered an emergency? Because we are renters with renter’s insurance, I’m largely unconcerned about stuff breaking in our home. Anything we really need, like major appliances, would be repaired by the management company. We don’t personally own anything super expensive that would constitute an emergency if it broke. Our renter’s insurance deductible is $500 – just in case our house burns down or everything is stolen or something.

How about your car(s)? What kind of insurance do you have on those? Are car repairs covered by a savings account or are they emergencies? We have comprehensive and collision insurance on the car we drive, and we could always switch to driving our other one if it is rendered inoperable (after re-insuring and re-registering). Our car insurance deductible is $500 and we have a savings account dedicated for car-related expenses, including repairs.

People in your family are the last major breakable thing. Insurance should take the brunt of these expenses after deductibles are met if your body breaks – health insurance, disability insurance, etc. You should also consider how you would travel to your family members should they need you and perhaps add that possible cost to your EF. We only have health insurance, but we have no dependents. Our health insurance (for each of us individually) has a $500 deductible and a $2,500 out-of-pocket maximum for coinsurance.

What’s a Reasonable Emergency?

Perhaps some of you think it is better to plan for the worst conceivable scenario, no matter how unlikely, but that’s not our personalities. I think a reasonable emergency scenario would be that one of us will fall ill and have to take a leave of absence from work (as far as I know we do not have access to any kind of disability coverage). This happened to a friend of ours a couple years ago. In addition to having only one income, perhaps we would max out our out-of-pocket pay for our insurance, $3000. We would need $600 to sustain us for a 6-month leave of absence. So that’s $3,600. We have our car insurance deductible covered by our Cars targeted savings account, but let’s say there was some accident at the house and we needed our renter’s deductible as well, $500. That’s a lot of terrible things happening at once!

It looks like a reasonable EF size for us would be about $4,000, assuming we still have our current targeted savings accounts in place. Obviously if both of us were unable to work and racking up health care costs we would be SOL no matter what size our EF was and we would just run through all our available assets!

General Savings and Tiered EFs

This post isn’t about where to keep emergency money, so I’ll just keep these comments brief. One of the reasons I’m comfortable with calculating a smaller EF is that we have a bunch of cash available in our targeted savings accounts and general savings that could be reassigned in the case of a big emergency. I don’t consider this true emergency savings because we are open to using it for other things. But I think it’s smart to have different levels of emergency funds available – some in cash, some in less accessible investments (we could eventually go into our student loan payoff money if needed), and even some credit if you’re comfortable with that.

Is your EF calculated for job loss or broken things or both? Do you care for/own a lot of potentially breakable things? How secure is your job/industry? Are you planning for a moderate-likelihood emergency or the worst case you can conceive of?

54 Responses to "What is the Purpose of an Emergency Fund?"

I think I’ve mentioned it to you before, but our views on EFs are that they’re largely based on what we might have to pay out of pocket if there is a natural disaster that has major implications on our lives and livelihoods.

We’d possibly need to pay: the hurricane deductible on both of our properties, car insurance deductible on both of our cars, and bare minimum living expenses, though the insurance on our duplex would keep income coming in there even if it were rendered uninhabitable, so that helps extend the “bare minimum”. If our properties were in different locations we might accept that the likelhood of disaster striking everywhere at once was rare and let it dip more, but it’s not outside the realm of possibility for a single hurricane to do major damage to all of our real estate assets, so we don’t double count deductibles there.Mrs. Pop @ Planting Our Pennies recently posted..What You Need To Know About Flood Insurance Changes – Part 1

We have 10 months of our current spending level in our EF. I feel like this is too much, but my husband refuses to have any less (he had a very hard time finding a job in 2009). We also haven’t come across any other pressing use for this money (student loans in deferment, not buying a house until after I graduate) but I think that we would be open to using it for something else if the occasion arose (supplement our car fund when it’s time to get another, for example). We currently keep our EF in our rewards checking account that earns 2% interest. We’ve explored other places to keep the money, but we can’t beat the 2% without taking on significant risk (unless you have any suggestions!). I think the way you have calculated yours seems perfectly reasonable, though!

I think a lot of the time “Emergency Fund” and “Planned Spending” get muddled in peoples heads because they both grow and just sit there until something comes up. I don’t think a furnace needing repair is an emergency – it’s only an emergency if you don’t have the money set aside in another account for planned spending.

Our Emergency Fund is striving for 10k (70% there!), but when you posted last about an EF I realized I would be pulling in around 2k in unemployment insurance should anything happen to my job. That said, I do not currently have disability/critical-care insurance, so that would be the weak point should something come up. It’s on my to-do list though.

Also, I just want to play devil’s advocate regarding the stability of PhD students (and obviously it changes depending on supervisor/school/your funding etc) but a good friend of mine had national scholarships (big money!) all through the first four years, and then entering her 5th year her supervisor couldn’t even pay the $800 it would cost in continuing tuition fees.

Research can be a cyclical thing dependent on funding (but you don’t get funding if you haven’t pumped out research… but you can’t pump out research if you don’t have funding to pay your students) and sometimes the funding dries up.Alicia @ Financial Diffraction recently posted..playing “what if” with personal finance.

I’m definitely trying to figure out for us how to draw the line between EF and planned spending. In this post, I guess I’m calculating a reasonable EF and the planned spending money would get pulled in if there is an unreasonable emergency. 🙂 If we didn’t have our targeted savings around, I probably would extend the bounds of a reasonable emergency to both of us getting sick and taking LOAs. And in reality people will use their assets however they see fit – the savings is around to keep us from running up credit card debt.

You are right that it is very dependent on the advisor and program. Some programs have guaranteed funding and some don’t. It stinks that your friend, obviously a great candidate, ended up in an underfunded lab. Did she pay the fees herself or graduate or what?

My PI keeps us all in the dark about funding but a grant Kyle helped write last year is likely going to be funded soon, so that’s why he’s able to stay as a postdoc (this is a switch from what he was told before they got the feeedback on that grant). My PI’s lab is large and still growing and he is well-established in the field so I assume he’s doing OK.

She ended up sucking it up and paying the fees as she didn’t want to have a poorly written product, but it was definitely aggravating for her after four years of not costing her supervisor a single penny.

I don’t think I’ve ever thought too hard about my EF. I just chose about 9 months of living expenses to be conservative. If something really bad did happen I imagine I could live on much less than I do now. I don’t have much stuff, besides my body that could break so if never though to calculate it that way.Cash Rebel recently posted..Would Give Directly work in the US?

Our EF is based on my self-employment and the fact that we have a house. If for example, our furnace need to be replaced, that would cost over $5,000, so we need a larger EF for any house repairs.Michelle recently posted..Being Defined By Your Job or Career

Kyle and I are not at all fearful of job loss or unemployment. I realize that is uncommon – it’s directly related to our positions as grad students.

It’s even unusual for graduate students. I need another year to finish my degree, but I don’t have guaranteed funding for it – likely due to the need for TAs, but not guaranteed. And then there’s the question of what happens after graduation! I know 4 recent PhDs in my field and related social sciences who’ve spent at least a year jobless or adjuncting. And my husband, who graduates this year with a lab science degree, doesn’t automatically get to stay on if he doesn’t find anything – it depends on whether someone has extra money in a grant for a postdoc, or needs an extra TA.

The idea of burning through the savings it took us three years to build in one year of unemployment kills me. The idea of using it up and still not having a job terrifies me, which is one reason we’re not dividing most of our additional monthly savings into loan repayment & retirement just yet – it’s like an emergency fund for the emergency fund. You can’t guarantee ANYTHING anymore, and if you can’t get a job, financial advice is pretty useless.

Oh, sorry for the confusion – I was not at all trying to say that grad students generally should assume their jobs are secure (although at my university I’ve yet to see someone kicked out purely for funding reasons). I was trying to say that while at other times in our life I will definitely be concerned about job loss, I’m not right now because we are in grad school. And that’s mostly because of the track record our PIs have in finding funding for their students and the assurance Kyle received from his PI that he can stay on as a postdoc after defending. Alternatively, we could delay our graduations until we find our next jobs. So I wasn’t trying to make a broad statement about grad students but just be honest about our attitudes at the present.

As for finding next-jobs that could definitely be a problem for me since I’m not sure what I want to do but Kyle was recently told by a recruiter that he will be able to find a job for sure because of his unique skill blend (even if it’s not his ideal job). We’re not striving for academic positions nor are we graduating at the same time so I think it’s pretty unlikely that we would both be unemployed simultaneously.

I think that since you’re acutely concerned about post-graduation unemployment, it’s smart to have a large EF. Probably most PhD students don’t think enough about how to fund their transitions out of grad school since it’s such a long process. Maybe I will write a post on that subject after looking up some stats.

I used my emergency fund a few times last year. I used it when I had to move on short notice and when I had a bunch of unanticipated medical expenses (but now I have my HSA for that). I also used it when my car was broken into. I also use it to help me feel comfortable about paying down the mortgage aggressively and to help me feel comfortable about buying my place in the first place. It would also help me if my HOA did a special assessment or if my appliances broke.

I’m not fearful of unexpected job loss, but of chosen (on my part) job loss. I actually have disability coverage through work and I would bring in more income than necessary to cover my expenses, so I’m not concerned about that. An unexpected unpaid leave of absence (e.g. a parent dying) needs to be protected against though.Leigh recently posted..2013 Savings Goals: Q3 Check-in

I’m not a big fan of basing an emergency fund off off of regular monthly expenses. Public safety nets take care of that for most people facing job loss.
The number I want to reach eventually us $3000. That its the size of my health insurance deductible, the largest single expense we are likely to face. It would alternatively cover any car repair up to total replacement with another cheap automobile.Edward Antrobus recently posted..Frugal Warning: Airborne Chewable Tablets

I was thinking of leaving the EF only at the health insurance out-of-pocket maximum, but it seemed low to me. I suppose if a car accident caused the medical bills those would eventually be reimbursed, but maybe we would need cash in the meantime.

I do not keep emergency funds held as cash. I would rather have my money work for me, so I keep it in index funds and some in bonds, both of which are liquid. So I can sell them off and use them for emergency needs whenever I like. There is some market crash risk with that but I am ok with that risk. Thanks for your thoughts!Lester recently posted..5 Best Credit Cards for Groceries

I probably will always want some part of our EF in cash, but if we want to keep a large one earmarked we might put a chunk of it in the market. I would be pretty nervous about losing principal just at the wrong time, though. I guess a long-term upside of 8% or whatever doesn’t feel as good to me as a possible 50% downturn does bad, if we wouldn’t have the option of riding it out.

Our emergency fund covers a year of expenses. We understand the opportunity cost of money, but in the scheme of things, our EF is still a very small percentage of our portfolio, and it allows us to sleep well. The reason for 12 month’s worth is because both my wife and I work in the same division of the same company. If the company decided to divest itself of our division, or even to downsize, we might both be looking for work. The other reason is that it typically takes longer for someone in their 50s (me) to find work.Bryce @ Save and Conquer recently posted..Networking to Help Our Niece Get a Job

You definitely have an increased risk there with working in the same department and commanding a high salary. I think if your EF in cash allows you to sleep at night, the opportunity cost is irrelevant!

We keep $10k for our emergency fund (roughly 5 months of our current spending, but we could stretch additional months if we went down to bare bones). Our primary reason for the EF is to cover a period of unemployment. I realize there are opportunity costs, but I am not particularly worried about what I might earn on the delta between our current EF and some other smaller EF (say, $5k), for the same reason I’m not worried about the cost of our home, health, or life insurance. There are a handful of unlikely but bad things that we want to guard financially against, and there are costs inherent with that. Like with everything, it’s just about the tradeoffs.Done by Forty recently posted..Notes from Peru

For sure there’s no one amount that will be right for everyone. It seems even the definition of an emergency can be up in the air at times. I think it all comes down to what if? What could happen that you would need to pull money out of thin air for? And if you did how much would you need?

I don’t have a ’emergency’ fund as such, but planned savings for other things (like putting on a mortgage in due course). It’s at $20k, which I said the other day would cover coming up to 10 months, whilst still paying mortgage and rent (and naturally in 10 months I’d have time to sell the property, or move back there, and not have rent, or move to my parents for ‘free’). If an emergency came, then I’d use that and the mortgage wouldn’t get it in the lump sum I plan to use it for. Likewise, in an emergency you could probably call in your camera money without too much worry (as in, in a true emergency you’d need and want that money more).

That being said, I’m tempted to get income insurance, which is another way to buffer unexpected breaks from work (namely injury and illness that’s not the employer’s fault). but then I think, well if I have cash, is it worth paying someone else money that they earn interest on, and I might never use? I suppose it’s the likelihood of being made disabled or permanently unable to work, which no emergency fund would cover but income protection could (in the right circumstances, like any insurance!)SarahN recently posted..Having time to think

For now that bolus of savings can serve as your EF, but what about when you are getting ready to disburse that money? How much would you save elsewhere to feel comfortable before putting that savings toward the mortgage?

When I put it to the mortgage, I’ll do it in an offset account, which means I can easily redraw it (based on what I know, I need to research more). But to answer your question, when I first put the lump to a mortgage, I reserved $10k for emergency and buying furniture (first house etc).SarahN recently posted..Having time to think

You can never say ‘we won’t lose out jobs’, since you never know what can happen. Usually, if all goes well and you have separate accounts/insurances to cover for most ‘mishaps’, a general EF might be useless. But then again tragedy strikes us sometimes and nothing we planned works anymore. So we’d rather have the peace of mind to know there’s something extra ‘just in case’, than deal with something serious and get into debt over it.dojo recently posted..Saving and Frugality: being frugal when it comes to pregnancy clothes

I think everyone needs to evaluate their own job and career situations. Once we graduate I will for sure be more concerned about job security and the time to find a new job, but it’s not a worry right now. There are plenty of people who were right about their job security, as well.

I didn’t try to predict the future. I just said I find the scenario of one of us (and especially both of us) losing our job to be unlikely and that I won’t spend time worrying about it. And that’s particular to our student status, the university we attend, the departments we’re housed in, and the labs we work in. I’m not trying to generalize to other situations.

There are lots of emergencies beyond just “breaking things and losing a job”

You lose your job AND your new one is in another state that you have to pay to move your household to.

Depending on the health insurance a person has… it will only cover 80% of a hospital visit. What if you get some odd infection or condition requiring a week or more stay in the hospital.

Disaster insurance. Double check any flood insurance you have. The type available in my area only covers water that travels along the ground. After specific questions I asked what about flooding from backed pipes? Nope. What about heavy rain? Nope that’s from the sky not traveling along the ground. Hurricane insurance is separate from flood insurance.

How long will insurance money take to get? Your house burns down and you lose everything. What if they take a week or more dragging their feet. Thats hotel, eating out, buying new clothes, new personal items (hair dryer, shaver, etc). All out of pocket while you wait for the insurance company to pay.

I was using “breaking things” to include natural disasters like the ones you mentioned. Very good point about looking into the specifics of the policies.

The health insurance issue is why I looked at both our deductible and our coinsurance out-of-pocket maximum.

I almost hate to say it, but the delay in insurance payments is why we’d be putting everything in an emergency situation on credit cards (our normal mode of spending anyway). That way there are a few weeks of buffer for the payment to come in, and if for some reason it won’t we would access our other investments to pay off the cards. If you don’t have access to credit though, that is a good reason to keep a larger cash EF.

Right on! About time people started questioning what is considered common wisdom. Emergency funds IMHO is not a one size fits all kind of thing. As with most financial decisions a lot has to do with ones financial situation, life and temperament.
Still, its something definitely worth having in whichever form for the peace of mind, things do tend to break down when you least expect them and life has a way of throwing curveballs from time to time which we can definitely cushion with an e-fund. How much and where to keep it though is upto someones liking after gauging their needs and financial situation.Simon @ Modest Money recently posted..TD Ameritrade Review – Exclusive Review of TD Ameritrade

I guess it’s just hard for me to believe that I’ll be hit with multiple independent emergency scenarios at once (to justify the large EF) when we’ve yet to have an emergency. Once we give up our DINK status I’ll probably be singing a different tune, though.

We keep a large emergency fund (about 6 months of regular expenses, 9 months of emergency expenses). For us it mostly comes down to the prospect of losing employment and having a young child (soon to be children) to care for. Things like car repairs and home maintenance (one we own a home) are handled by other savings.

I do think there’s a certain point at which we will no longer need a dedicated emergency fund, but that will be when our liquid assets are large enough that a significant loss in value wouldn’t leave us under-protected. At that point I would feel safe investing the money rather than keeping it in a savings account.

FYI, you do have access to disability insurance whether or not your employer offers it. In fact, I would recommend that everyone get individual disability insurance separate from anything their employer offers if they can, because it travels with them no matter where they work. I would seriously look into it.Matt Becker recently posted..Staying Safe With DIY Car Repairs

So you are really keeping job-loss funds as well as repairs funds on hand simultaneously, because of your savings system – interesting.

For now all our long-term savings goes into our Roth IRAs, which I don’t want to touch ICE. Once we are maxing out all our tax-advantaged retirement accounts and are saving more in taxable accounts, I might be comfortable not having an EF, like you said.

I misspoke regarding the disability insurance. You are right that we could purchase it privately, but we haven’t. Our employer doesn’t give students disability insurance and we are also not eligible for SSI disability because we having been paying payroll taxes. Our plan is to buy it after we graduate.

The other thing about disability insurance is if your employer provides it, any disability payments will be taxable as income. If it is insurance that you have paid for, the disability payments will be non-taxable.Bryce @ Save and Conquer recently posted..Do You Hide Things From Your Spouse?

We do have lots of breakable things, including a $10,000 health insurance deductible. I don’t plan on getting that sick, but one accident or crazy illness could do it. We also have rentals, so we tend to keep more in liquid savings that some people would. I am not really worried about job losses, although that is always a possibility. I think we are diversified enough to weather one of us losing a job or having a pay decrease. It’s the thought of sickness or disability that worries me more.Kim@Eyesonthedollar recently posted..Please Vote To Help My Business

[…] What Is The Purpose of An Emergency Fund – Evolving Personal Finance Getting into the nitty gritty of emergency funds, Emily looks at the function of emergency funds and the factors to consider when calculating the size and sum of yours. […]

[…] assumes that the emergency you are protecting against is income loss. You could also choose to enumerate all the vital ‘things’ in your life that could break (your body, your house, your car, etc.) and add up the deductibles you would have to pay to fix […]